The Senate is considering the JOBS bill this week. The bill looks to make it easier for companies to go public by reducing some of the cost and complexity involved in the IPO process. By making it easier to go public, the idea is that companies will go public earlier, and hopefully grow more quickly. Senate Democrats have concerns, and are afraid this represents a rollback of legislation designed to “stop the next Enron”. They also see advocates of this bill, including venture capitalists, as looking to profit by taking companies public and selling them off to unsuspecting investors at inflated prices.
On much of this discussion there is little new to say.
All parties would agree, because the facts prove it, that small businesses do not provide job growth, and neither does “Big Business”. What provides job growth are small businesses that grow fast to become big businesses. Apple, Cisco, Genetech and Home Depot, all started small, grew quickly, and went public. They and companies like them have provided all the job growth in the US for the last twenty years.
All parties would agree, because the facts prove it, that despite a recent slight upturn, there have been less IPO’s in the most recent decade then the prior one. I would then assert that given less of the one thing that used to create all the jobs, it is no surprise that there has been less job growth in the past decade, than in the prior one.
All parties would agree that regulations such as Sarbanes Oxley imposed cost and delay on small companies looking to go public but also mean that companies that do go public are on average longer established and have better systems and controls.
The substance of the debate, and where the parties clearly do not agree, is whether the above trade off is worth it. Is it worth it to have less IPO’s and have them happen later, if in return, those IPO’s that do take place, are less risky? I don’t think so.
The Sarbanes Oxley Act tries to protect investors against the kind of corporate fraud that sank Enron, Tyco and Worldcom. It does this by requiring a layer of cost and compliance that is manageable for a large Fortune 1000 company but can be easily 10% of the profits of a typical high growth IPO. The debate ignores the fact that none of the poster children for corporate fraud were the type of early stage high growth companies that would be the beneficiaries of the reduced regulation in the JOBS Act.
High growth early stage IPO’s absolutely are risky investments, but not because they have or do not have Sarbanes Oxley (SOX) type controls. They are risky because high growth companies are intrinsically risky and for every Apple that works, there are five apples that didn’t. The most significant impact of SOX on smaller companies in the last ten years, is that boards have decided to “wait a year or two” before going public so as to be bigger and more established before exposing the company and the board to the costs and risks of being a public company.
The result for public investors has been they have had less opportunity to lose money in risky high growth start ups in the last ten years. To that extent the regulatory mission has succeeded. The bad news is public investors have made less money too. Cisco, Apple and Yahoo all went public relatively early in their lives, and made public investors great returns, more than enough to cover losses incurred on less successful companies that went public at the same time. By contrast, Facebook is going public with $ 4 Bn in revenues and valued at $50 Bn plus. The upside has gone to the insiders not the public investors.
This illustrates the least understood part of this debate. When IPOs are scarce, private investors end up make more money not less, although the returns take longer. In general the current SOX regime has been a negative for early stage investors – by making exits take longer – and a positive for the much larger group of late stage financial investors, – by eliminating competition from the IPO market. This is precisely the wrong result from a policy perspective.
Public investors know this. Large mutual funds the work for the average investor have started to “reach down” into pre public rounds because they know that is where they can make the return that their customers, individuals saving for retirement, want and need. Do opponents of the bill recognize that they have put mutual fund managers between a rock and a hard place? They have to find high growth companies but unless the system is fixed, they can only find them in the private market, with much less investor protection.
It is clear that the trend to delayed IPO’s has cost the investing public in terms of lost investment profits. It is harder to prove the direct impact of SOX and the dearth of IPO’s on jobs. However I think the burden of proof on this issue is on the other side. When you can point to a process (IPO’s + high growth companies) that has created almost all the job growth in the US since the 1980’s and Congress passes a law that visibly impedes that process, and then job growth subsequently stalls, surely the burden of proof is on the other side? How can the AFL-CIO even think about voting for another jobs decade like the last one ?
All regulations, including the ones that the JOBS bill is looking to reduce, have both costs and benefits. For large public companies I believe SOX compliance is a manageable cost and a worthwhile obligation. For high growth IPO’s the benefits of SOX are light and the costs, have been significant. IPO’s have been reduced, job growth has been lower, public shareholders have been shortchanged and the benefits of the American economy have once again been channeled to a smaller group of investors who can work the system. It is time to change the law.